SEC Committee on Crowdfunding

The SEC Investor Advisory Committee recently had a meeting with one of their topics Crowdfunding. They came out with six recommendations:

1. Tighter restrictions on the amounts investors can invest in crowdfunding

For non-accredited investors, the committee recommends a “lesser of” approach. The investment limits will be the “lesser of net income OR net worth”, 5% of whichever is less would be the amount they can invest (if either is under $100,000), 10% if BOTH are over $100,000. Accredited investors should see no change.

I’m not sure how this plays out for retirees who might have reasonable nest eggs but small incomes. No mention of changing the definition of accredited investor, which hasn’t had any inflationary adjustments in 30+ years.

2. Strengthen mechanisms for investment limits

The main crux of this recommendation is that online portals should provide a worksheet for net worth calculations to guide investors through the process, based on thinking that most people don’t know their net worth or are ill equipped to calculate it correctly (can’t count your primary residence and need to deduct various liabilities)

The committee touches on something that seems more daunting, the idea that an investor can easily circumvent requirements by investing in multiple platforms. That the commission should incentivize the creation of a cross portal monitoring system – which has got to be a daunting task and I think it would alienate investors knowing that a bunch of their investment information is being pooled on them.

Currently, online platforms are somewhat limited on the criteria they can use to vet deals for listing on the platform. In the case of a consumer lending, this is pretty benign. In the case of more complex online marketplaces, the SEC might consider the vetting process the same as "endorsing a deal". At this point, a platform would need to register as a Broker Dealer. The relevant quote:

Moreover, while we appreciate the Commission’s efforts to carefully consider what actions by funding portals would necessitate regulation as broker-dealers, the Committee questions the logic of restricting funding portals’ right to curate offerings based on its evaluation of the quality of those offerings or on any other criteria determined by the portal. Just as brokers are permitted to restrict the range of their offerings without being deemed to be making a recommendation, funding portals should enjoy a similar freedom subject to appropriate restrictions designed to ensure that they do not present their offerings in a way that will be perceived as making a specific recommendation by investors.”

4. Ensure educational materials have required info and are understandable

The committee recommends that the commission, securities regulators and FINRA develop a sample guide designed to educated investors. Additionally, they recommend the questionnaire for investors might contain a test that investors actually read and understood the disclosures. I don't think this will materially impact investor acquisition. This is a one-time deal for new investors who can then go on to invest to their hearts content (up to investment limits of course).

5. Electronic Delivery definition

The committee feels that the definition won’t actually ensure adequate delivery of disclosures. They specifically call out platforms that send emails stating “We have information for you, come log in and see it”. A quote that resonates with me:

In addition, it poses a significant risk that issuers and intermediaries would use this less transparent delivery mechanism to deliver information they prefer to obscure, thus lending itself to disclosure practices that are not simply opaque but also abusive.

This is particularly relevant when a platform doesn’t want to field a support call or email for someone they aren’t interested in doing business with – think Adverse Action disclosures or FCRA messages to borrowers who have been turned down.

6. The elimination of the integration doctrine is too much

The integration doctrine says that an issuer must make a judgment on a series of offerings, that if they are substantially the same they must be viewed as an integrated whole to determine if they qualify for the private placement exemption. If the integrated offering does not meet the criteria for the exemption, neither can the individual offerings.

The committee is suggesting throwing out the integration doctrine wholesale isn’t the right way to go, but that instead they should take a measured approach and to evaluate the correct level of regulation.